Wednesday, July 20, 2011

Gang of Six Plan: Right Answer or Smoke and Mirrors?

It's a real question; I haven't looked into the details of the plan and any serious effort to do so would probably take a good deal of work. The plan as described seems to me a sensible compromise along the lines I suggested in an earlier post: "Raise" taxes only by eliminating tax expenditures, features of the tax code designed to subsidize particular taxpayers and activities. And the gang of six proposal claims to do it by broadening the base enough to lower marginal rates, thus reducing the inefficient incentives due to the tax system.

What I don't know is how much substance there is to the proposal, in particular to the expenditure cuts. Does it go beyond "spend $X less on program Y," which is likely to get changed at the point when it is supposed to be implemented and supporters of program Y point out all the terrible consequences—as has happened repeatedly with bogus medicare cuts? Or is more of it along the lines of "raise the age of eligibility for Social Security by a month a year for the next twenty-four years," which one can imagine actually happening and which would have a significant effect?

Any readers who have looked more carefully at the proposals than I have and would like to comment?

Suppose we look at the same question from the other side. Obama proposes, and congress passes, a change in the tax law, under which every tax payer gets his taxes reduced by a thousand dollars a year--whether or not he is paying taxes. So somebody who starts with tax liability of zero--true of a large fraction of all taxpayers under the federal income tax--gets paid a thousand dollars a year.

That isn't too far from what actually happened. Is it a tax cut? Or an expenditure increase?

Suppose we add one more fact—that most of the people who pay no federal income tax are still paying federal taxes. Most of them pay payroll taxes, most of them pay more for goods due to tariffs, and although calculating tax incidence if hard, most of them probably pay more as an indirect effect of federal corporate taxation.

Now is the change I described a tax cut or an expenditure increase? How, in principle, do you distinguish between taking less from people and giving more to them, when you are already engaged in both taking and giving?

Not directly related to the "Gang of Six" plan, but related to the debt ceiling debate:

Couldn't the Federal Reserve write off some of the debt that is owed directly to them? This would have the effect of not only lowering the outstanding principal, but lowering the interest payments. What do they have to lose, other than their credibility?

"Now is the change I described a tax cut or an expenditure increase? How, in principle, do you distinguish between taking less from people and giving more to them, when you are already engaged in both taking and giving?"

Here's an attempt at answering your excellent question, although some (re)definitions are probably necessary. The underlying framework is to estimate NET figures to determine the final impact of the tax policy in terms of "tax cut" or "expenditure increase".

Inflows to the government are defined as 'taxes', outflows from government as 'expenditures'. Net revenue to the government is inflows less outflows. After the policy change, examine the reduction in inflows (call this reduction in inflows the 'cut'), and the increase in outflows (call this the 'expenditure increase').

In all cases shown in the hypothetical data below, the net revenues to the government would be reduced equally (45). But the impact in each case would be defined differently in terms of NET tax cut or NET expenditure increase. In Case 1, the reduced inflows > increased outflows and could be called a "net tax cut." In Case 2, the reduced inflows < the increased outflows and could be called a "net expenditure increase."

Proposed Tax Policy: $1000 tax cut

The blog doesn't allow for ease of presentation but here's a try:

Prior to policy change

(A) inflows ('taxes') = 100

(B) outflows ('expenditures') = (50)

(A)-(B) net revenue to government 50

CASE 1. NET TAX CUT SCENARIO

After policy change:

(A) inflows = 75 results in change of (25) due to reduced inflows = the 'cut'

The Gang of Six Plan, like most plans, are designed to game the CBO and JCT scoring systems, not actually accomplish the headline selling point.

For example, The Gang of Six promise to permanently "fix" the AMT, which is scored as a massive tax cut under current law. Under current reality, it doesn't cut anything because the AMT "fix" is passed every year as a one-off provision.

Another example: The Gang of Six propose that a future congress be obligated to cut $200,000,000,000 from a program designated by such future Congress. This "law" is scored as a saving, but "reality" says no future congress will do any such thing.

More shenanigans appear because scoring is over 10 years so you can float this year's $1,400,000,000,000 deficit is masked by cutting expenses in 2022.

These are not minor touch ups, the entire plan is built on such gamesmanship.

The discussed revenue raisers and tax expenditures are teeny, tiny items to the 2011-2012 budget, but incredibly important to GOP and Democratic posturing and fundraising.

Washington seems to be in the grip of a peculiar insanity, with almost everyone (including the "sophisticated" financial press) holding the belief that the government is literally in funding trouble, like Greece. Of course any trouble is entirely artificial. It should be obvious, but for some reason isn't, that the government can never run out of its own money (goods and services are scarce; money is not). Further, the facts of high unemployment and low inflation strongly suggest that the deficit is too low, not too high. You would think that increasing the deficit would be easy, but no. Politicial inertia works against increasing it as well as decreasing it.